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In This Issue.
* A desperate move...
* Europe unhappy with FOMC move...
* Commodity currencies move higher...
* Precious metals take a wild ride...
And Now... Today's Pfennig!
A $900 billion mistake...
Good day...Another fun day in the currency markets yesterday as the combination of election results and the Fed's desperate actions led to some pretty dramatic volatility. Later this morning we will see if the Fed's move has forced their counterparts in England to follow course. The Fed's move has caused a flurry of negative comments coming from the Asian continent, where the dollar weakness is causing real concern (Ben is giving the Chinese a bit of their own medicine!). The weekly jobless claims and third quarter productivity and labor costs reports should make today another fun one on the desk. But I will begin with what looks like a very desperate move by the Fed.
The Federal Open Market Committee announced they would be purchasing $600 billion of treasury securities over a time period ending in June of 2011. These security purchases will be concentrated in the 3 to 7 year area with an average duration of 5-7 years. The official statement said the purpose of these purchases was to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate. The FOMC also directed the NY Fed to continue to reinvest principal payments from agency debt and agency mortgage-backed securities into longer-term Treasury securities. Based on current estimates, the NY Fed expects to reinvest another $250 to $300 billion over the same period. This brings the total of the stimulus package to just under $1 trillion dollars.
Chuck is enjoying a working vacation with his beautiful bride down in Cabo, but he is keeping a close eye on the volatile markets and sent me the following to share with you today:
Well. I don't want to take away anything that Chris wanted to tell you about the FOMC's decision yesterday to implement Quantitative Easing again (first time was March 2009). I'm going to focus on something that I doubt most will. and that is, simply that the FOMC backed itself into a corner. they probably don't see it that way, but if there's one thing I learned in business school it's that you don't give a time or an amount unless you're 100% sure you will meet those targets. Once the FOMC said that the buying would end by next June, and total $600 Billion, they set themselves up for a big failure. and loss of credibility. Sure, the FOMC did retain their ability to adjust the pace and total, no one will remember that 5 months down the road, when FOMC officials begin talking about more QE being needed. And they will, because, they are of the belief, wrong so, I might add, that QE, will create jobs, and loans, and all other things needed to kick start the economy. It doesn't, and we all know that!
So. I thought long and hard about this, and remembered something I learned years ago, and that is when you, as a business, state an exact time and end date, the institutional momentum takes over, and when the FOMC comes back to do more QE it's going to be very difficult. the markets will punish them severely.
There.just a different angle of thought from the cheap seats here in Cabo San Lucuas, Mexico!
Chuck shares some good company in his thoughts that the Fed will need to do more easing beyond the current round (QEIII !!). Mohamed El-Erian who is PIMCO's chief executive officer sounded alarms that the Fed's bond purchases could backfire. He warned in an article on ft.com that some of the money pumped into the US will leak out to other nations, strengthening currencies in countries that need weaker exchange rates. He worries that the Fed's actions could cause a round of protectionism. He also warned that the Fed will probably need to come back and increase the stimulus beyond the $600 billion which they announced. Like Chuck said, the Fed has backed themselves into a corner with this announcement, let's just hope things are better next June.
This was a desperate move by the Fed who obviously believes they have no other options available. After all, their first round of QE sure wasn't dramatically successful! The purpose of the QE is to try and pump money into the system so that banks will have more to lend and businesses and individuals will borrow and spend, propelling the economy forward. Quantitative Easing is supposed to act a lot like spraying starter fluid into an engine, giving it a quick burst of energy to get it going. Last year the starter fluid seemed to work, as the economy jumped forward during the last half of the year, but it quickly sputtered back to a halt early this year. In spite of the $1.7 trillion the FOMC through at the markets back in March of last year, businesses and consumers didn't feel comfortable borrowing and spending. And can you blame them with unemployment hovering near record highs?
But the Fed has to keep the stock market strong and the economy expanding at a faster pace than just 2%; so they decided to try another round of stimulus. Do they really think this will work any better than the first round? I think their QE II will only make things worse, as it will flood the international markets with new US$ and ultimately push the value of the dollar lower. The only real solution to the current state of the economy is time. It is going to take time for businesses to innovate and for workers to be retrained. The government should be using the money they are throwing at the Treasury markets to encourage new industries and products. After all, not all of the global economy is in the funk that the US and Japan have gotten into. I read in our local paper that Boeing is looking for thousands of new airplane orders from a booming Chinese airline market. And St. Louis' own Emerson Electric had a record quarter of growth thanks to strong Asian demand for their electrical components. The government needs to encourage these US companies with incentives and help in training new workers. This doesn't happen overnight, but it is the only way I believe we will be able to permanently turn this economy around. But enough of the soapbox, let me get back to what you want to hear about; the currency and metals markets.
The dollar climbed a bit just before the announcement yesterday afternoon, as some currency traders were obviously making some large bets the stimulus would not be as big as expected. But the dollar fell dramatically as soon as the announcement was made with the euro gapping over one cent in the matter of a minute or two. A half hour after the FOMC decision, the markets had settled with a modest fall in the US$ as most had expected. But overnight the Asian investors started to sell dollars and the selloff accelerated as European markets opened up this morning. The European currencies of Sweden, Norway, and Denmark had the biggest moves vs. the US$ after the kiwi which was the number one performer (more on that later).
Sweden's Prime minister Fredrik Reinfeldt has been a vocal critic of those countries who are using their currencies to try and gain a trade advantage. This is one of the reasons the markets have made the Swedish krona the best performer against the dollar since mid-June. Chuck sent me an excellent article from Bloomberg which detailed the Prime Minister's thoughts on currency manipulations and his country's plans for recovery. You can read the entire article by going to http://www.bloomberg.com/news/2010-11-02/sweden-tells-currency-manipulators-to-find-alternative-competitive-edge.html but here are some good excerpts:
"Sweden has moved on from the idea that you can only maintain competition through currency manipulation," Reinfeldt said. "Currencies are going to play a part because there are different developments in different countries so this is certainly going to be an issue," Norway's Finance Minister Sigbjoern Johnsen said in an interview in Oslo today. Sweden's krona is the best performer against the euro and the dollar since mid-June of the 16 major currencies tracked by Bloomberg, having gained 2.6 percent against the euro and 17 percent against the greenback in the period. Reinfeldt signaled the gains may continue, given the outlook for Sweden's economy. "It is not difficult to understand the strengthening of the krona when looking at the Swedish fundamentals at a time when many other countries have deep problems," he said.
The largest Nordic economy will expand 4.8 percent this year, the government estimates, putting it on track to deliver the European Union's biggest rebound as it recoups most of 2009's 5.1 percent contraction. Sweden also boasts the EU's smallest budget deficit. The central bank has raised rates three times since July as it steers the economy through the recovery. Policy makers lifted the benchmark a quarter point to 1 percent last month.
You can see why investors have flocked to Sweden, and the recent data suggest the krona will continue to rally. Chuck came up with a basket CD several years ago which combines all three of the Nordic countries into one great investment vehicle. The Viking basket CD is made up of 40% Norwegian krone, 30% Danish krone, and 30% Swedish krona. This is an excellent way to invest into these three currencies with just a $20,000 investment.
I have dragged on a bit this morning, and the BOE just announced that they will not be following in the Fed's footsteps. The BOE announced they will keep their asset purchase target at 200 billion pounds choosing not to increase it further. The move was largely expected, as recent data suggests England's economic recovery is starting to gain traction. UK GDP rose .8% in the third quarter, twice the pace economists had expected. Inflation concerns have also increased as prices rose 3.1% in September, slightly above the government's 3 percent limit. The BOE did keep their interest rates unchanged at .5%, as expected.
The ECB will be making their announcement a little later today, and are also expected to leave rates unchanged. But the Fed's move yesterday may keep the ECB from beginning the withdrawal of their own stimulus. ECB President Jean-Claude Trichet has been hinting that he would start to remove some of the stimulus measures put in place during the sovereign debt crisis. But yesterday's Fed decision has complicated the ECB's exit strategy. An announcement of stimulus withdrawal would probably cause another round of euro buying by investors who have lost faith in the US$. The ECB will need to weigh the inflationary risks of leaving the stimulus in place vs. the negative impact of a stronger euro. I believe they will probably choose to error on the hawkish side, and go ahead and continue to withdraw the added stimulus. Worries about future debt problems with some of the weaker European nations should help cap any euro rally, keeping the upside of the euro below $1.45 for the near term.
The Bank of Japan will be the last major central bank to announce their rate decision, and they are expected to follow the Fed in announcing more quantitative easing. The US has followed Japan into this quagmire of low growth, low inflation, and near zero interest rates. In spite of a very weak economy, the Japanese yen has continued to appreciate vs. the US$, and the BOJ will likely announce more QE in order to try and keep the yen from further gains.
The New Zealand dollar was the biggest gainer vs. the US$ over the past 24 hours, climbing over 1.5%. The kiwi rose to within spitting distance of .80 cents and is now trading at the highest level since 2008. The NZ$ was helped by a government report which showed the jobless rate dropped to a seasonally adjusted 6.4% in the 3rd quarter. This report, along with recent strength in commodity prices, will likely push Reserve Bank of New Zealand Governor Alan Bollard to increase interest rates sooner than he had originally planned. Interest rate differentials continue to encourage investors to move funds out of the US$ into the higher yields available in New Zealand, Australia, South Africa, and Brazil. The South African rand strengthened to a two week high vs. the US$ and the Canadian dollar continues to hover around parity with the greenback after yesterday's FOMC decision.
I received an email from a reporter just after the FOMC announcement wondering why Gold had sold off so dramatically. The email caught me off guard, as I had been focused on the currencies and hadn't seen the $30 sell off immediately following the QEII announcement. After talking it over with some of the others on the desk, we settled on a logical explanation. Metals investors read through the FOMC announcement and realized the Fed cannot see any signs of inflation on the horizon, and is in fact more concerned with the risks of deflation. Since gold is seen as a hedge vs. inflation, the metals traders sold as they no longer felt the need to keep their hedge. I figured this sell off would be short lived, and encouraged investors to take advantage of the lower prices.
As Chuck has told Pfennig readers for years, gold is not just an inflation hedge, it is an UNCERTAINTY hedge. I don't think we have ever been in a position of more uncertainty here in the US and across the globe, so Gold is still a good place to invest. And it looks like the markets agreed with our thoughts, as gold made up all of its $30 drop overnight and continues to rally this morning (it is up $31 as I finish this paragraph!
Recap: The FOMC announced a desperate $900 billion effort to revive the US economy, a move which has questionable chances of succeeding. Europe is not following in the Fed's footsteps, and their currencies will appreciate because of it. The Nordic currencies were some of the best performers vs. the US$ overnight. The BOJ will likely be the only central bank to side with the fed, and will probably announce additional stimulus measures later today. The commodity currencies continue to rally led by the Kiwi, and gold has a wild ride.
Currencies today 11/4/10: American Style: A$ 1.0106, kiwi .7914, C$ .9975, euro 1.4238, sterling 1.6171, Swiss $1.032, European Style: rand 6.8228, krone 5.7438, SEK 6.5196, forint 190.94, zloty 2.7454, koruna 17.2018, RUB 30.7225, yen 80.95, sing 1.2829, HKD 7.7508, INR 44.21, China 6.6622, pesos 12.2183, BRL 1.6898, dollar index 75.89, Oil $85.86, 10-year 2.57%, Silver $25.36, and Gold. $1,379.43
That's it for today. I am expecting another busy day on the desk, as it is the funding deadline for our latest MarketSafe CD (more info on that above). This week has been tough, and I am starting to drag a bit. I always gain a bit more appreciation for the job Chuck does day in and day out in putting this Pfennig together when I have to do it for more than a few days. It looks like a beautiful fall day here in the Midwest, and I am excited to get to go watch the Blues keep their home win streak alive tonight against the San Jose Sharks. Christine is here with the breakfast sandwiches, so that is my queue to get this out the door. Hope everyone has a Thundering Thursday!!
Chris Gaffney, CFA
EverBank World Markets
11-04-2010 10:20 AM